2016 (9) TMI 907 - AT - Income Tax

Royalty Payments: Independent Comparables Key for Arm's Length Price

Sara Lee TTK Ltd. (Formerly known as Sara Lee Household and Body Care India Ltd., now amalgamated into Godrej Consumer Products Ltd.) Versus DCIT Range-10 (2), Mumbai

The Tribunal remanded the case to the Assessing Officer for proper benchmarking analysis of royalty payments in license agreements. It emphasized the ... Royalty payable to the Associated Enterprise - whether was to be restricted to 1 % of the qualifying Net Sales as against the rate of 50/0 of the qualifying et Sales as computed by the appellant - TPA - Held that:- From the record we found that the assessee did not bench mark the royalty payment separately. On enquiry by TPO, it has relied on RBI approval given in 1995 and also on the fact that the assessee earned a gross profit of 41.6%. TPO applied Press Note 9(2000 series) and restricted it to 1% on the plea that the payment was for use of trademark without transfer of technology. The assessee has not separately benchmarked the Royalty transaction at the time submission of Form 3CEB or at the time of preparation of Transfer Pricing Report. It is settled proposition of law that it is the onus of the assessee to prove that the transactions were taken at arm's length. Going by the relevant TP provisions as enshrined under the Act and relevant Rules, it is mandatory that the appellant has to independently benchmark its international transaction with independent comparables so as to arrive at arm's length price, which has not been made in this case. The comparability analysis is the substratum of determining the ALP, which has not been done by assessee at any stage. At the very same time we found that the revenue authorities have not properly appreciated the relevant clauses of the trademark licence agreement, precisely the clauses which were highlighted by ld. AR during the course of hearing before us. Therefore, in the interest of justice and fair play, this case should be restored back to the file of AO, ho shall require the assessee to bench mark its international transaction of 'royalty' with independent comparables following suitable methods prescribed under the Act and on its compliance, the AO after giving adequate opportunity to the assessee shall decide this issue in accordance with the TP regulations. - Decided in favour of assessee for statistical purposes. Issues:1. Interpretation of royalty payment terms in license agreements.2. Benchmarking analysis for royalty payments.3. Relevance of government approvals for transfer pricing purposes.Issue 1: Interpretation of royalty payment terms in license agreementsThe appellant, engaged in manufacturing and sale of products, entered into a license agreement for the use of knowhow, formulae, and trademarks. The agreement was extended with approval from regulatory bodies. The Transfer Pricing Officer (TPO) restricted royalty payment to 1% based on a press note, as the appellant failed to provide comparable license agreements. The Commissioner of Income Tax (Appeals) upheld the decision, stating that the approvals obtained were for manufacturing/collaboration, not specifically for trademark use. The appellant argued that the agreement involved technology transfer, not just trademark use. The Tribunal found that the appellant did not independently benchmark the royalty transaction, as required by law. The case was remanded to the Assessing Officer for proper benchmarking analysis.Issue 2: Benchmarking analysis for royalty paymentsThe appellant relied on government approvals for royalty payment benchmarking, but the TPO and CIT(A) emphasized the lack of independent comparables. The Tribunal noted that the appellant did not benchmark royalty payment separately, leading to the application of a 1% restriction by the TPO. The RBI approval was deemed irrelevant for determining Arm's Length Price (ALP). The Tribunal highlighted the necessity for independent benchmarking to establish ALP, citing the Punjab & Haryana High Court's decision. The approval rates by DIPP and RBI were deemed for different purposes and not indicative of ALP. The Tribunal directed the appellant to benchmark the royalty transaction with independent comparables following TP regulations.Issue 3: Relevance of government approvals for transfer pricing purposesThe Tribunal clarified that government approvals for royalty payments do not determine ALP and cannot serve as valid Comparable Uncontrolled Price (CUP). The approvals are granted for ease of business and foreign exchange management, not for ALP determination. The Tribunal emphasized the need for independent benchmarking to establish ALP, as mandated by TP provisions. The case was remanded to the Assessing Officer for proper benchmarking analysis to determine the arm's length price for royalty payments.In conclusion, the Tribunal allowed the appeal for statistical purposes, directing the appellant to conduct proper benchmarking analysis for royalty payments with independent comparables to determine the arm's length price in accordance with transfer pricing regulations.